Opinion: Tesla will win out in the end because it’s following the Amazon model

TimMullaney

Writer

The chattering class is all a-twitter, literally and figuratively, about Tesla passing Ford to become Earth’s second-most-valuable car company, worth about $50 billion before even making consistent profits. But it’s not as crazy as it sounds — in fact, it isn’t crazy at all.

To veterans of the internet-valuation wars, the argument recalls debating when Amazon.com
AMZN, +1.24%
would go bankrupt. In that fog, vapidity went halfway around the world before lucidity donned boots. Sub-arguments about when Tesla’s
TSLA, -2.46%
Model 3 sedan will ship, or whether it had dumb reasons for shipping fewer cars in a quarter than expected, both often cited as proof Tesla isn’t all that, for 2002 debates over whether companies would deny Amazon credit and you’ll realize: It’s the same conversation.

Bears are likely wrong — no one has a crystal ball — about a number of small things. But here’s the big thing: History says that with growth stocks like Tesla, if the innovation is big enough, arguments about valuation and tactics come out in the wash. And emissions-free transport, probably leading soon to driverless cars, is a really big innovation.

With that in mind, look at the purest recent bull argument on Tesla, from Morgan Stanley’s
MS, +1.08%
Adam Jonas, who thinks the stock is worth $305 and can make an argument for nearly $500 if car sales beat expectations. (The stock today trades at about $300.) The bear case comes from Goldman Sachs’
GS, +1.19%
David Tamberrino, who recommends selling Tesla and says the shares are worth a still-considerable $187.

First off, I left out any valuation of Tesla’s SolarCity business, which installs rooftop solar systems for homeowners, or its plans to start an Uber-like business called Tesla Mobility, which Jonas values at $76 a share pre-launch. Mobility is, for now, vaporware, and SolarCity has challenges with regulation and competition that I’ll skip.

The main questions are: How many cars is Tesla likely to sell, and what profit will it make selling them? Tesla’s auto business alone is worth $233 a share to $337 (Jonas) or $146 (Tamberrino). On the questions that determine whether those valuations are right or wrong, both analysts are arguably conservative — and Jonas’ arguments make more sense than Tamberrino’s.

There are 400,000 Model 3s on back-order, at prices beginning at $35,000 but expected to run as high as $70,000 with options. Despite what you read by young journalists driving old Toyotas, these prices are nothing exceptional: The average new-vehicle price is $34,342 and a loaded, gasoline-powered Audi A4 costs $55,000; Audi sold 337,000 A4s last year.

Likewise, Tamberrino sees Tesla getting no more efficient at manufacturing as it gets bigger, which basically never happens. He says gross profit margins — the amount left over after actually making cars — will decline from around 23% of sales through 2019. Jonas has gross margins at 27% in Tesla’s auto segment in 2020.

Then Tamberrino assumes Tesla gets only minor economies of scale on marketing, and research and development as it grows. His model says Tesla, which reportedly spends $6 a car on advertising, will have sales, general and administrative expenses in 2020 that are 20% of sales versus 8% at Ford
F, +0.42%
now.

This isn’t the history of growth companies, whose high valuations stem from their ability to make lots of money once they begin making profits at all.

If Tesla can get 2020 auto sales to the $25.7 billion that Jonas foresees, with 27% gross margins, Tesla at today’s $49.8 billion valuation will turn out fine. Overhead will scale if Musk makes it scale. R&D spending depends on how aggressive management is in new businesses (Amazon CEO Jeff Bezos’ investments in Amazon Prime and cloud-computing services scared the Street for years): Musk could trim R&D but probably won’t. Whether Tesla beats Tamberrino’s 2019 forecasts for $2.76 billion in earnings before interest, taxes, depreciation and amortization is, therefore, pretty much up to Musk. By 2020, $4 billion is possible, though Jonas says it will happen in 2021.

Goldman’s 2019 number puts Tesla at 18 times the more conservative analyst’s view of EBITDA two years out — emphatically not crazy for a transformational grower.

Here’s the hole card: Not even Jonas much emphasizes the Model Y small SUV coming after the Model 3, though he thinks it will become the most popular Tesla yet. Tamberrino only acknowledges that one risk to the bear case is “incremental new product announcements.’’ Incremental, as in, Tesla entering a small-SUV market that generated 2.7 million U.S. unit sales last year?

Nail the 3 and the Y, and Tesla stock actually has room to run. The rest — Tesla Mobility, the solar business, selling batteries to other carmakers — will be gravy. Ford will have ... the Taurus. (Not fair, but funny.)

As always, Tesla boils down to whether one believes in Musk. I look at Musk and see Bezos, whose big bets deferred profits and scared half of Wall Street. Was last month a better time to buy, before Tesla jumped 30%? Absolutely. But there will be dips, and chances to exploit them.

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